7 Reasons Why Teachers Need a Roth IRA

The Roth IRA is the most unusual retirement plan, and probably the most versatile. Even though you may participate in the retirement plan in your school district, there are excellent reasons why teachers need a Roth IRA.

Think of it as a way to broaden your retirement horizons. Once you learn what a Roth IRA can do for you, you’ll want to get one started right away.

What is a Roth IRA and How Does it Work?

A Roth IRA is similar to a traditional IRA, but with a few very important differences.

Similarities between a traditional and Roth IRAs include:

  • You can make an annual contribution of $5,500 per year, or $6,500 per year if you are age 50 or older.
  • Investment income accumulates in the plan on a tax-deferred basis.
  • You can begin taking withdrawals from the plan, without being subject to a 10% early withdrawal penalty, beginning at age 59 ½.
  • Both a traditional and a Roth IRA can be a self-directed account, held by the investment trustee of your choice.
  • There is practically no limit as to what you can invest a traditional IRA or a Roth IRA in.

Those are the similarities between the two IRAs. Here are the differences, and they’re major:

  • Contributions to a Roth IRA are NOT tax-deductible. If that sounds like a bad deal, read the next difference…
  • Withdrawals taken from a Roth IRA are tax free, as long as you are at least 59 ½ years old, and the plan has been in existence for at least five years.
  • Withdrawals of contributions taken prior to turning 59 ½ can be taken free from both taxes in the 10% early withdrawal penalty. Early withdrawals of investment earnings however are subject to penalty.
  • Roth IRAs are not subject to required minimum distributions (RMDs). (RMDs are an IRS requirement that you begin taking distributions from your plan beginning at age 70 ½.) Roth IRAs are the only retirement plans that are not subject to RMD’s.

Don’t worry if you don’t understand what I’ve just written. We’ll go over each in more detail, as a way of showing you how a Roth IRA can be a big opportunity for you.

Roth IRA Contribution Eligibility

You can contribute to a Roth IRA plan as long as your income doesn’t exceed certain thresholds. This is true whether or not you are covered by employer-sponsored retirement plan.

The income thresholds for 2017 are:

  • Married filing jointly – phaseout begins at $186,000, and is no longer allowed at $196,000.
  • Single or head of household – phaseout begins at $118,000, and is no longer allowed at $133,000.
  • Married filing separately – contributions are not allowed if your income exceeds $10,000.

Those are the basics of the Roth IRA. Now let’s focus on why you need to have a Roth IRA of your own.

7 Reasons Why Teachers Need a Roth IRA

We’ve just covered the basic rules on how Roth IRAs work. But now let’s discuss in practical terms why teachers need a Roth IRA.

1. Increasing the Amount of Money You Put Away for Retirement

Let’s say that you earned $60,000 per year in your teaching position, and you’re allocating 10% of that to your 403(b) plan. You’ve chosen 10% because your employer will do a 50% match up to 5%. That means that between your contribution and your employer’s match, 15% of your pay, or $9,000 per year, is going into your retirement plan.

If you make a Roth IRA contribution of $5,500 per year, that increases your total contributions to $14,500 per year, or nearly 25% of your salary.

That may seem like a lot of money to contribute. But it’s exactly the kind of strategy that you might want to use under any of the following three circumstances:

  1. You only recently began contributing to your employer plan, and you want to contribute as much as possible to make up for lost time.
  2. You want to fast-forward your retirement contributions early in your career, so that you can lower your contributions in the future (or maybe even stop making them).
  3. You’d like to retire early, and you know that the only way you’ll be able to do that is by saving as much money for retirement as you can.

Let’s spend a little bit more time on point Number 3. One of the problems of early retirement is that you won’t be able to withdraw money from your retirement plans before age 59 ½, without being subject to ordinary income tax and the early withdrawal penalty.

But remember we said earlier that your contributions can be withdrawn from a Roth IRA at any time, without being subject to either income tax or the early withdrawal penalty? That makes a Roth IRA the perfect source of income for someone who wants to retire early.

It’s just something to think about!

2. Creating Income Tax Diversification in Retirement

Since withdrawals can be taken from a Roth IRA account tax-free after age 59 ½ (and as long as you have been in the plan for at least five years), having one is a way to have at least some of your retirement income sheltered from income tax.

This is an underestimated benefit of the Roth IRA. If you participate in a 403(b) plan, and will have a pension and Social Security when you retire, you could be in much higher income tax bracket than you expect. It’s even possible that you’ll be in a higher tax bracket than you are right now.

Having a well-stocked Roth IRA will provide you with an income source that will not increase your tax liability. If nothing else, it can serve as a source of tax-free income in those years during retirement when your income is unusually high. For example, you can decide to take more distributions out of your Roth IRA, and forgo distributions from your 403 (b) plan.

By giving you options to lower your tax liability in retirement, a Roth IRA provides retirement tax diversification.

3. Having More Investment Options

One of the most common complaints about 403(b) plans is limited investment options. Many districts limit your choices to insurance annuities or target date funds, both of which have very high investment fees. Still other plans may limit you to a very short list of mutual funds or exchange traded funds (ETFs), that have load fees or may not be the types of funds that you really want to invest your money in.

Since a Roth IRA is typically a self-directed account, you can choose the investment brokerage that will hold the account. Since most large brokerage firms offer almost unlimited investment options, having a Roth IRA is a way that you can diversify beyond the limited investments in your employer plan.

For example, you can have your 403(b) invested in one or two annuities, or even a target date fund. But you can have your Roth IRA account invested in the funds that you choose. You can even choose to hold money in individual stocks or bonds. If you’re an experienced investor, you could consider trading options and futures through your Roth account. It’s really up to you.

4. Having Greater Control over Your Long-term Savings and Investments

A 403(b) plan is an excellent long-term savings plan. That means that it’s perfect for retirement. But if you’re like most people, and you have most of your money tied up in your retirement plan, it means that most of your money is out of reach.

That’s because employer-sponsored plans tend to limit your access. Some will enable you to take loans against your plan. But of course that means that you will have a repayment. Some employers don’t even allow you to take loans. And almost none allow you to make withdrawals prior to either retirement or your termination from employment.

You can often mitigate this problem by having a generous emergency fund. But what if you need money for something more substantial than a short-term emergency? I’m thinking of the down payment on a house, the need to pay off a large amount of credit card debt, or even costs associated with putting a child through college.

Any of those situations could require that you have access to a significant amount of your biggest asset. For all the reasons stated above, that can be a problem.

But if you have a Roth IRA, you will have direct access to the funds in that account. You won’t have to go through the bureaucratic process of taking a loan or requesting a hardship withdrawal. As the owner of your account and the manager of your investments, you would be able to access the account anytime you want.

Which gets us into advantage Number 5.

5. Taking Tax-Free Withdrawals

A Roth IRA is virtually the easiest retirement plan to take early withdrawals from.

We noted that one of the differences between a Roth IRA and a traditional IRA is that you can withdraw your contributions from the plan at any time. Those withdrawals will not be subject to either ordinary income tax or the 10% early withdrawal penalty.

Under IRS ordering rules for Roth IRA withdrawals, when you make withdrawals from the Roth IRA, the first funds that are taken out are your contributions. This is a rule that’s unique to Roth IRAs.

As an example, let’s say that you have $10,000 in a Roth IRA. $6,000 represents your contributions, and $4,000 is the investment earnings on those contributions. You decide to take a $5,000 withdrawal from the plan.

Since the $5,000 that you want to withdraw is less than your $6,000 in plan contributions, the withdrawals can be taken without creating a tax liability. The Roth IRA is the only retirement plan in existence were this is possible. All others require a pro-rata allocation of the withdrawal between contributions and investment earnings.

Now if you were to withdraw the remaining $5,000 later in the year, then only $1,000 could be taken free from taxes. The remaining $4,000, because it represents your investment earnings in the account, will be subject to both tax and penalty if you haven’t turned 59 ½.

Naturally, taking early distributions like this is not something that you want to do on a regular basis. But it’s good to know that the option exists for you to make withdrawals without also creating a tax liability.

6. Having at Least Some Money that Isn’t Subject to RMD’s

On virtually every other retirement plan, you must begin taking required minimum distributions (RMDs)
no later than age 70 ½. That means that you have to take them, even if you don’t need the money.

At age 70 ½, RMD’s work out to be about 4% of the value of your plan. Since the distributions are based on your remaining life expectancy, the distributions will get a little bit higher each year.

What makes people nervous when it comes to RMD’s is a potential to outlive your money. After all, if you’re required to take the distributions, it is possible to deplete your accounts.

Having a Roth IRA guarantees you will have at least one tax-sheltered retirement plan that is not subject to RMD’s. You can take withdrawals from your other plans, while leaving your investments intact in your Roth IRA.

The advantage is that the Roth IRA can continue to grow while you’re drawing down the other plans. This means that you will never run out of money.

Just as important, a Roth IRA enables you to preserve retirement capital to pass on to your heirs. You will be able to ensure that at least the funds in the Roth plan will be available to pass on to your children at your death, even if every other account has been drained by RMDs.

7. Having a Roth IRA in Place in Case You Want to Do a Roth IRA Conversion

Roth IRA conversions have become enormously popular in recent years. The reason why this is true is because people want to move their retirement money from plans that have taxable distributions, over to the Roth IRA where they won’t be taxable.

With a Roth IRA conversion, you can convert money from your 403(b) plan to a Roth IRA. Once you do, the money in the Roth IRA will be available for tax-free withdrawals.

Here’s a simple explanation for how a Roth IRA conversion works…

Let’s say that you have $100,000 in your 403(b) plan. You want to convert that balance to your Roth IRA. After you’ve transferred the money into the Roth IRA, you will have to pay tax on the amount of the converted balance.

If you are in the 15% tax bracket at the time of the conversion, then you’ll have to pay $15,000 in ordinary income tax ($100,000 times 15%). The remaining $85,000 in your Roth IRA will continue to build investment earnings and to grow.

Once the money has been in your Roth IRA for a minimum of five years, you will be able to begin taking withdrawals from the plan free from income tax.

In this way, you will convert an otherwise taxable income source to a tax-free source.

If you plan to do a Roth IRA conversion, and there’s a very good chance that you will once you get near retirement age, having a Roth IRA in place will have an account available for that purpose. It will remove at least one step from the Roth IRA conversion process.

How to Open Up Your Own Roth IRA

Are you sold on the idea of the Roth IRA yet? If you are, you’ll be pleasantly surprised to know that it’s one of the very easiest plans to open.

As long as you are within the income restrictions listed earlier, all you need to do is decide what type of investment account you want to hold the money in. It can be a discount brokerage service, where you can trade in any securities that you like. It can also be a mutual fund family, a managed investment account, or even a robo-advisor.

Once you choose the broker, all you need to do is contact them. Once you let them know that you want to open up a Roth IRA account, they’ll tell you exactly what you need to do, and handle all of the paperwork for you.

You can fund the account out of other savings or through regular contributions. And as we discussed above, you can also do a Roth IRA conversion, where you move money into the Roth IRA from other retirement plans.

Whatever brokerage firm you choose, and however you decide to fund your account, once you do, you’ll have all of the benefits of a Roth IRA that we discussed.

Even though you’re covered by an employer plan, a Roth IRA is still in excellent retirement strategy. It’s a way of moving some of your retirement eggs out of a single basket, and into it alternate account that will open up an entire host of benefits that other plans can’t provide.